Commodity Futures Trading Commissioner Speaks about Cyber Threats

Guest Lecture of Commissioner J. Christopher Giancarlo, Harvard Law School, Fidelity Guest Lecture Series on International Finance Speeches & Testimony – CFTC

December 1, 2015

Given in Dedication to the late Dr. H.R. Giancarlo, M.D. – 1932 – 2015, who dared to go so much farther than his birth or circumstances warranted so that his sons and grandchildren could journey even further.


Good morning, ladies and gentlemen. Thank you for your warm welcome.

Before I begin, let me say that my remarks reflect my own views and do not necessarily constitute the views of the Commodity Futures Trading Commission (CFTC or Commission), my fellow CFTC commissioners or the CFTC staff.

I would also like to dedicate this lecture to my father, Dr. Hector Giancarlo, who passed away a few weeks ago.

In June of this year I celebrated my first anniversary as a Commissioner of the CFTC. As a new market regulator and a long-standing supporter of thoughtful swaps market reform, I have met with fellow global financial regulators in Washington, London, Geneva, Hong Kong and Beijing. I have spoken to and heard from market participants in the U.S., Europe and Asia, from hedge funds to large corporations, from commodities traders to major money center banks and from futures exchanges to swap execution facilities (SEFs). I have also traveled to Minnesota, Kentucky, Texas, Iowa, Illinois and Indiana, meeting with farmers, dairymen, pork producers, row crop farmers, oilmen, energy producers and industrial manufacturers, who all use derivative products to control production costs and other risks.

Before being sworn in as a Commissioner, I served for thirteen years as a senior executive of a leading operator of electronic and hybrid trading platforms for cash and derivative products. In that role, I helped build a global business that fosters trading liquidity for thousands of institutional clients in instruments from corporate fixed income to interest rates, foreign exchange, equities, energy and commodities.

I provide this background to demonstrate how my business experience in global markets, combined with my current role at the CFTC, gives me a critical understanding of U.S. and global financial markets and the major challenges facing them today. My experience informs my view over how best to enhance the health, vibrancy and resiliency of financial markets. My priority is and will always be the ability of financial markets to durably serve their core constituencies: entrepreneurs and capital raisers, risk hedgers and speculators, retail investors and end-users, savers and retirees.

Backward-Looking Debate

Yet, in my first year in Washington, I have been struck by how backward-looking much of the discussion is around global financial markets. The Dodd-Frank Act was passed over five years ago, but U.S. market participants and Washington financial regulators must still spend much of their professional time arguing over and addressing its myriad mandates and peculiar prescriptions – regulatory edicts ostensibly designed to prevent a recurrence of the last crisis. The same is true for much of the European and Asian discussion around the G-20 regulatory reform efforts initiated in Pittsburgh in 2009 and coordinated by the Financial Stability Board (FSB).

The hue and cry of the ongoing financial market reforms under Dodd-Frank and the FSB leaves market regulators and participants with very little available bandwidth to assess and prepare for the next financial crisis – a crisis that will certainly be unlike the last one.

Just as “peacetime generals are always fighting the last war” and “economists fight the last depression,” so too do financial regulators outlaw past market abuses that are not a looming threat to our financial markets and economies. The Dodd-Frank Act and its unceasing implementation are uniquely positioned to ensure U.S. market regulators stay focused on the past.

Allow me to use a simple analogy. U.S. market regulators are riding together in an automobile on a high-speed interstate highway. The Dodd-Frank Act is an oversized rear-view mirror covering almost the entire windshield. That rear-view mirror directs our attention to the enormous amount of rules and requirements generated over the past five years that need to be completed or reworked to meet Dodd-Frank’s never-ending demands. Meanwhile, financial markets continue to evolve and pass by at remarkable speed. New dangers are coming right at us. As we regulators barrel down the road of 21st century financial markets, we must shed this backwards-looking approach to regulating or we will not be able to see the oncoming traffic and looming dangers ahead.

This evening, I would like to spend some time pushing aside that clunky rear-view mirror and taking a clear view at the challenges for capital and risk-hedging markets in the first quarter of the 21st century.

I believe there are six developments that are transforming global financial markets today. They are:

1. Cyber Threats;

2. Disruptive Technology;

3. Government Intervention;

4. Market Illiquidity;

5. Market Concentration; and

6. De-Globalization.


1. Cyber Threats

I remember the day like it was yesterday. It was a bright and sunny, late summer morning in Manhattan on September 11, 2001. I was at work at 100 Wall Street when I felt a thud and heard a bang. Minutes later, smoke was coming from the side of the North Tower of the World Trade Center. After dismissing office staff, I boarded a packed East River ferry that rounded Manhattan’s Battery. I witnessed with my eyes bodies leaping from the flaming Twin Towers. I watched each tower shudder and slowly collapse downward into a cloud of smoke and devastation. I mourned that day and ever after the death of friends, neighbors and financial industry colleagues. I have not forgotten.

The victims of 9/11 died at the hands of determined plotters who sought not just human slaughter and destruction of a symbol of western capitalism, but destruction of the financial markets and the U.S. economy.1 As we all know, they were not successful, but that does not mean the threat to our economic way of life has dissipated.

In fact, the U.S. Department of Defense has identified cyberspace as a new domain in warfare as critical to military operations as land, sea, air and space.2 Such efforts continue today in the form of relentless cyber-attacks on U.S. financial market participants. In 2012, then-U.S. Defense Secretary Leon Panetta warned of a potential “cyber-Pearl Harbor.”3 More recently, my colleague, CFTC Chairman Timothy Massad, noted that cybersecurity is the most important single issue facing our markets today in terms of market integrity and financial stability.4 I fully agree.

Market regulators should have no illusions about the fact that cyber belligerents – both foreign and domestic – view the world’s financial markets as 21st century battlefields.5 Cyber enemies could use a range of new battlefield tactics to try to cripple financial markets, from destroying the course of banking and trade settlement transactions6 to using poison pill algorithms to flood markets with bad data and fake trades in order to drive trading volatility and market collapse.7 And attacks would not just be directed to Western financial markets: all markets around the globe are vulnerable to attack, whether as a primary target or an attack response.8

I spoke in Hong Kong a few weeks ago and outlined a principles-based approach for combating cyber threats.9 That approach is premised on a close and dynamic relationship between competent national cyber defense agencies and financial market participants. It seeks to stimulate the continuing “bottom-up” development of best practices, defensive strategies and response tactics through the leadership of financial marketplace leaders, operators and self-regulatory organizations. The approach is cognizant of the rapid evolution of cyber threats. It would avoid imposing on market participants dated mandates to respond to last year’s dramatic cyber-attack that consume precious resources needed to prepare for what will happen tomorrow. Rather, regulators must use many carrots and a few sticks to flexibly move financial market participants and operators to a state of continually optimized and up-to-date cyber defense.

Cyber hostilities will not end anytime soon – they will be relentless for years, if not decades, to come. As “mega trends” go, cyber risk is the number one threat to 21st century financial markets. It is a threat for which Dodd-Frank provides no guidance whatsoever. As market leaders and regulators, we must make it our first priority in time and attention. We must leave no step untaken or precaution unavailed to thwart cyber destruction of the world’s financial markets.

2. Disruptive Technology

These 21st century cyber threats exist within the context of a new phase in human history, when exponential digital technologies are rapidly changing the very nature of human identity, work, leisure and society. Contemporary financial markets will experience this evolution most acutely in three areas: automated electronic trading, blockchain ledger methodology and financial cartography.

A. Automated Electronic Trading

The electrification of trading over the past 30 to 40 years and the advent of exponential digital technologies have transformed financial businesses, markets and entire economies, with dramatic implications for capital formation and risk transfer. In U.S. futures markets, we see this change most presently in the area of algorithmic or automated trading. Automated trading now constitutes up to seventy percent of regulated futures markets.10 It will continue to dominate trading with new and innovative developments far into the future. Automated trading can lower transaction costs while increasing trader productivity through greater transaction speed, precision and sophistication.11 For many markets, automated trading brings trading liquidity, broader market access, enhanced transparency and greater competition.12 Such features are all the more beneficial in the wake of departing bank liquidity.13

At the same time, automated trading presents a host of new challenges. They include increased risk of sudden spikes in market volatility and “phantom” liquidity arising from the sheer speed of execution,14 flawed algorithms15 and position crowding.16 They also include the risk of data misinterpretation by computerized analysis and mathematical models that increasingly replace human thought and deliberation.17 Legal scholars raise important questions about the viability in automated trading markets of traditional market regulation,18 as well as securities law concepts such as mandatory disclosure and fraud-on-the-market theory.19

How global market regulators in markets such as New York, Chicago, London, Hong Kong and Shanghai handle this change from human to automated trading will be extremely important. It requires delicate balancing. To ensure vibrant, accessible and durable markets, we must cultivate and embrace new technologies without harming innovation. Without doubt, there must be effective safeguards of market integrity and credibility, but those safeguards should not bar promising innovation and continuous market development.

In that same Hong Kong speech I outlined a principles-based approach to automated trading.20 In this time of rapid technological innovation I believe any hard and fast regulatory specifications or restrictions on automated trading will be obsolete by the time they are published in the Federal Register. The only effective way for a regulatory agency to stay abreast of the rapid advances of trading automation is to be informed through an ongoing bottom-up process. That is, through industry working groups composed of leaders of automated trading firms setting industry best practices and procedures. Such best practices should then be set as standards and routinely updated by market self-regulatory organizations. Regulatory frameworks for automated trading must enhance, not stifle, industry best practices. They must be informed by technological innovation and improvement, not media headlines, best-selling books or political campaign agendas.

Last week, the CFTC issued proposed rules for the registration and regulation of automated trading. I voiced many reservations about the proposal, and I look forward to reviewing the public’s well-considered and thoughtful comments.

It is hard to deny that finance is increasingly becoming an industry where machines and humans are swapping their dominant roles – transforming modern finance into what scholar Tom Lin has called “cyborg finance.”21 This sea change in the roles of man and machine will have wide-ranging impacts on financial markets, alongside dramatic changes in law, market regulation and human society. Again, Dodd-Frank offers no answers for this challenge. Nevertheless, market regulators and policymakers must address it head on.

B. Blockchain

The 20th century underpinnings of the current “closed ledger” financial system are inefficient and unstable. At present, centralized third parties authenticate financial information in generally three-day settlement timeframes that add undue risk, cost and volatility to the marketplace. The 2008 financial crisis revealed that a portion of the recordkeeping infrastructure of the multi-trillion dollar swaps market was recorded on handwritten tickets faxed nightly to the back offices of market counterparties.22

Distributed open ledgers have the potential to revolutionize modern financial ecosystems.23 Unlike current settlement processes, distributed ledgers use open, decentralized, consensus-based authentication protocols.24 They allow people “who have no particular confidence in each other [to] collaborate without having to go through a neutral central authority.”25 Distributed ledgers will have enormous implications for financial markets in payments, banking, securities settlement, title recording, cyber security26 and the process of collateral management that is made infinitely more complex by new regulations.27 Open ledgers may make possible new “smart” securities and derivatives that can value themselves in real time, automatically calculate and perform margin payments and even terminate themselves in the event of a counterparty default.28

Enormous resources are being invested in developing the distributed open ledger known as the blockchain. Over two dozen major global banks have joined together in a consortium to build a framework for using blockchain technology in markets.29 The London Stock Exchange, CME Group, Euroclear, Societe Generale and UBS have set up the Post Trade Distributed Ledger Working Group to look into how blockchain technology can be used in clearing, settlement and reporting of trades.30

The Bank of England has called the blockchain the “first attempt at an ‘internet of finance’”31 with the potential to de-centralize legal recordkeeping the same way the Internet de-centralized data and information. This transformation will not come without consequences, however, including a greatly disruptive impact on the human capital that supports the recordkeeping of contemporary financial markets. On the other hand, the blockchain will help reduce some of the enormous cost of the increased financial system infrastructure32 required by new laws and regulations, including Dodd-Frank.

C. Financial Cartography

Network science is an interdisciplinary scientific field that enhances human understanding of the networks that make up the natural and scientific world, from biological to technological systems. Financial network science was pioneered by academics in the 1990s and continues to be advanced in leading university financial research departments.33 The continued development of interactive financial network maps allows analysts to explore and diagnose systemic fragilities and mitigate critical vulnerabilities and escalating risk patterns.34 Systemic risk maps can also serve as mass collaboration platforms to harness network intelligence.35 Drawing upon newly evolving peer-to-peer methodologies, real-time financial cartography may allow organizations and regulators to proactively address emergent systemic market risk.

At the heart of the 2008 financial crisis was the inability of regulators to assess and quantify the counterparty credit risk of large banks and swap dealers.36 The legislative solution was to establish swap data repositories (SDRs) under the Dodd-Frank Act.37 Although much hard work and effort has gone into establishing SDRs and supplying them with swaps data, seven years after the financial crisis the SDRs still cannot provide regulators with an accurate picture of bank counterparty credit risk in global markets.38 That is because international regulators have not yet harmonized global reporting protocols and data fields across international jurisdictions.39 Certain provisions of Dodd-Frank actually hinder such harmonization, despite widespread bipartisan legislative support for their correction over the past two Congresses.40

Of all the many mandates to emerge from the financial crisis, visibility into counterparty credit risk of major financial institutions was perhaps the most pressing. The failure to accomplish it is certainly the most disappointing, especially as the emerging science of financial cartography is so promising. Global regulators cannot by themselves achieve the objective of full counterparty credit risk transparency. What is needed is a concerted effort by regulators, academics and the private sector that draws on the emerging network science of financial markets. It is well past time to make that happen.

3. Government Intervention

We are amidst an extraordinary period of governmental and central bank intervention in the U.S. economy that is widely distorting the nature and functioning of global capital markets.

Since the 2008 financial crisis, the Federal Reserve (Fed) has made itself an increasingly outsized player in the U.S. government debt markets, roughly quintupling its balance sheet from $905 billion in early September 2008 to almost $4.5 trillion today,41 equal to one-fourth of the U.S. economy and nearly five times its pre-crisis level.42 Through its “quantitative easing” (QE) program, the Fed has purchased an unprecedented 61 percent of all Treasuries issued, peaking at close to 80 percent in 2014.43

Today, the Fed has become the multi-trillion dollar “Washington Whale.”44 Its intervention in the Treasury and mortgage-backed security markets misprices the true cost of credit below its natural level and distorts the integrity of prices and exchange rates.45 The Fed is having an increasingly direct and immediate impact on all other markets, from corporate bonds to equities and foreign exchange rates to developing nations’ sovereign debt.46 It has reduced the heterogeneity of the investor base, herding it into one-way bets on anticipated changes in Fed policy rather than traditional fundamental credit or value analysis.47 According to one veteran observer, the Fed’s “exceptional measures” have “conditioned financial markets to develop a deep dependence on the central bank as a suppressor of financial volatility and a booster of financial asset prices.”48

The Fed’s outsized market participation contributes to greater market volatility. It hazards periods of sharp illiquidity in response to relatively normal market shocks as crowded market participants quickly seek to adjust such correlated positions upon the slightest hint of changes in Fed policy.49 It has increased the risk that when investors rush to reduce these correlated positions, they will flood the market, causing a pronounced drop in prices and the possibility of a new crisis.50

The Fed is not the only central bank engaging in such extraordinary market intervention. The phenomenon extends to the People’s Bank of China (PBOC),51 the Bank of Japan52 and the European Central Bank (ECB),53 the priorities of which seem to be market stability over vitality and price setting54 over integrity of asset values.55

These days, market leaders and regulators who have responsibility for market health and safety must account for the impact of the Fed’s role as the “Washington Whale” and that of its overseas brethren. Central banks have replaced major dealers and money center banks as marketplace Leviathans plunging into increasingly shallower pools of trading liquidity. With one flip of their policy tails, these central bank behemoths can whack a whole lot of smaller market participants out of once-liquid markets and leave them stranded.56 As market overseers, we must understand the risks posed to market liquidity and price integrity by the ballooning role of central banks in increasingly shallower financial markets.

4. Market Illiquidity

Market participants know that liquidity is the lifeblood of healthy trading markets. In essence, liquidity is the degree to which a financial instrument may be easily bought or sold with minimal price disturbance by ready and willing buyers and sellers. Quantifying liquidity is challenging, but not impossible. A range of characteristics such as market depth, width, volume, resiliency, immediacy, participation and turnover can more readily qualify it.

Today it is widely apparent that many of these liquidity characteristics have been fundamentally changed in many asset classes and markets. Accounts of liquidity distortion extend from U.S. Treasury securities57 to German Bonds,58 corporate bonds,59 equities,60 U.S.61 and euro62 interest rate swaps, single-name credit default swaps (CDS),63 cross-currency swaps,64 repos65 and energy swaps and futures.66

Concerns about deterioration of trading liquidity have been voiced by the International Monetary Fund (IMF),67 the Bank for International Settlements (BIS),68 the Bank of England,69 Federal Reserve Chair Janet Yellen,70 financier Stephen Schwarzman of Blackstone71 and noted economist Nouriel Roubini.72 While some central bankers voice skepticism over a lack of quantitative evidence of illiquidity,73 there is real concern among those with financial market responsibility and knowledge, including financial market regulators74 and important market participants from Goldman Sachs75 and Credit Suisse76 to Blackrock77 and the Development Bank of Singapore.78

We saw evidence of such pronounced liquidity contraction this past August in enormously volatile equity markets, when major global banks focused on executing trades for their clients rather than for their own account.79 We saw it in June with sudden spikes in the German Bond market.80 We saw it a year ago when the market for U.S. Treasury securities, futures and other closely related financial markets experienced an unusually high level of volatility and a very rapid and pronounced round-trip.81 A few weeks ago, Chairman Massad cited new CFTC research showing that “flash” volatility spikes have become increasingly common, with 35 spike events so far this year in core futures products such as corn, gold, WTI crude oil, E-Mini S&P and Euro FX.82

Traditionally, large global money center banks served to reduce such market volatility by buying and selling reserves of securities and other financial instruments to take advantage of short-term anomalies in market prices.83 Their balance sheets served as market “shock absorbers” in times of market turbulence. Now, market “shock absorbers” seem to be a thing of the past. Throughout these recent sharp volatility episodes, banks appear to have been unable to step in aggressively to provide additional trading liquidity.84 According to one senior banker, “Wall Street’s role as an intermediary and risk taker has shrunk.”85 This evolution appears to have been underway for some time.86

A major catalyst of the reduced bank trading liquidity in financial markets is the new regulatory policies of U.S. and overseas bank prudential regulators imposed in the wake of the financial crisis. Arising from the political narrative that the financial crisis was primarily about deregulated banks engaged in excessive trading leverage rather than a burst bubble of toxic mortgages and mispriced credit, many new financial sector regulations are disproportionately focused on capital adequacy of banks and financial institutions without corresponding attention to housing finance reform. Most of the new regulations have the effect of reducing the ability of medium and large financial institutions to deploy capital in trading markets. Combined, these disparate regulations are already sapping global markets of enormous amounts of trading liquidity. Many of these new rules were cobbled together in the United States’ Dodd-Frank Act, the European Union’s European Market Infrastructure Regulation (EMIR)87 and Markets in Financial Instruments Directive II (MiFID II),88 the Basel III accords89 and regulations by other overseas authorities. Many of these reforms have ostensible and varied merit, and each has a supporting constituency. Yet, almost all of these rules continue to be promulgated by U.S. and overseas regulators in an uncoordinated and ad hoc fashion with a paucity of predictive analysis of their impact on global trading markets.

Dodd-Frank and other new rules dictated by U.S. and European central bankers and bank prudential regulators with little practical understanding of trading markets seek to control borrowing and leverage in the financial system. Yet, they are tying up billions in capital on the books of global financial institutions. The rules prioritize capital reserves over investment capital, balance sheet surplus over market-making and systemic safety over investment opportunity. They include regulatorily-imposed margin payments on uncleared swaps,90 enhanced central clearinghouse recovery procedures,91 capital retention and leverage reduction requirements under the Basel III accords92 and other rigid leverage ratios and edicts from loosely organized global shadow regulators like the Swiss-based FSB.93 Further included is the financial transaction tax sought by the Obama Administration94 and a “systemic risk charge” (tax) that the Treasury’s Office of Financial Research (OFR) recently proposed to impose on members of clearinghouses.95

In response to the deluge of capital-constraining regulations, major money center banks are today building up large balance sheet reserves instead of putting their capital to work in the markets and the economy. Large banks have dramatically reduced their inventories of Treasury and corporate bonds and other financial instruments.96 For example, it is estimated that in the $4.5 trillion bond market, banks hold just $50 billion of corporate bonds, compared with $300 billion before the financial crisis.97 Even the 2015 annual report of the Financial Stability Oversight Committee (FSOC) created by the Dodd-Frank Act fully acknowledges that banks and broker-dealers are reducing their securities inventories and, in some cases exiting markets.98 This lack of inventory deprives markets of the “shock absorber” mechanism that dealers traditionally provide. Without it, it is much harder to execute large trades without moving the market, causing greater price volatility.

In trying to stamp out risk, global regulators are instead harming trading liquidity. Capital-constrained banks and other market makers have little choice but to limit their exposure to increasingly fragmented markets, especially in the event of financial turmoil. It has reached such a level that the IMF recently issued a report discussing the need for more, not less economic risk-taking to help global recovery.99 The report calls on banks to revamp their business models to once again become engines of growth.  Yet, the IMF neglects to call out bank regulators for restricting the banks’ ability to put their capital to work.100

A recent report by the OFR asserts that changes in financial market structures caused by new regulations are reducing the willingness of some major market participants to smooth out volatility in global financial markets.101 According to this study, these changes will cause the U.S. financial system to become more vulnerable to debilitating financial market shocks.102 Fed Chair Janet Yellen recently acknowledged concerns that market liquidity may deteriorate during stressed conditions due to new regulations, among other factors.103

Some believe that new, non-bank entrants into financial markets will compensate for reduced bank trading capital.104 They contend that bank liquidity will be fully supplemented by proprietary firms using automated trading algorithms with greater speed, accuracy and transaction volume than traditional bank trading desks.105 Others are less sanguine that the void of bank trading liquidity can so readily be filled by newer market entrants with far smaller balance sheets that cannot access now-constrained bank capital.106

Heightened market volatility is unlikely to be only the result of prudential regulations constraining bank capital, but may also derive from evolution of some trading markets from dealer to agency models, the unique nature of automated trading and the impact of U.S. and European monetary policy, which (as noted in Part III supra) has led market participants to enter crowded, one-way trading postures in anticipation of changes in central bank moves rather than fundamental value analysis.107

Whatever the exact mix of causes, the fact of disappearing trading liquidity and sharper volatility will have enormous implications for 21st century markets. The question that must be asked is whether the amount of capital constraint bank regulators are placing on financial institutions is properly calibrated to the amount of capital that those institutions need to deploy to support market health and vibrancy. Those of us with direct responsibility for overseeing financial markets need to ask that question, even if bank prudential regulators will not. We need to understand the full implications of constrained bank capital on market health and resiliency and the ability of financial markets to underpin sorely needed global economic growth. Once again, Dodd-Frank provides no answers.

5. Market Concentration

A wave of consolidation is taking place across the financial landscape, concentrating the provision of essential market services within fewer and fewer institutions. It is now widely recognized that Dodd-Frank regulations have wiped out small community banks across America’s agriculture landscape.108 It is less well-acknowledged that large banks are broadly reducing market services, jettisoning less-profitable clients and increasing some fees on others in such critical areas as prime brokerage and administrative services.109 A similar narrowing of market services is taking place in the swaps market, where rising regulatory costs are driving consolidation of transaction service providers into a few remaining major SEFs.110

This wave of consolidation is perhaps most glaringly apparent in the case of America’s futures commission merchants (FCMs). While not a household term, FCMs are the futures markets equivalent of stock brokers, providing critical services for businesses that need to hedge against business and production risks. Today, because of a combination of mismanagement, U.S. monetary policy and over-regulation, FCMs are becoming an endangered species, with dire consequences for America’s smaller farmers, ranchers and manufacturers.111

Industry consolidation derives from several factors. Fraud and mismanagement caused spectacular failures of well-known firms Refco, MF Global and Peregrine Financial. The prolonged U.S. monetary policy of near-zero interest rates has eliminated a key source of income for FCMs through reinvestment of customer money.112

Another threat to FCM survival comes from burdensome new regulations. The collapse of MF Global and Peregrine Financial prompted a series of new customer protection rules,113 some of which were undoubtedly needed, but which have impacted small FCMs more harshly than large ones. The CFTC adopted new rules on ownership and control reporting that greatly increased compliance and paperwork burdens for FCMs.114 The CFTC further expanded FCM recordkeeping obligations to include the recording of all oral and written communications that lead to the execution of a transaction.115 A supplementary leverage ratio (SLR) issued last year by U.S. prudential regulators will make it more expensive for bank-owned FCMs to clear customer trades.116 That is because the SLR requires banks to hold more capital for every asset on their books, even margin held for clients in segregated accounts, 117 leading to diminished FCM margins and increased client costs.118

FCMs as an industry are spending millions of dollars for infrastructure, technology and compliance personnel to implement these complex regulations. Smaller FCMs that traditionally serve agricultural and small manufacturing interests must devote precious resources to comply with cumbersome rules more easily handled by large bank-affiliated competitors. FCMs are also overwhelmed by a significant increase in demands for information from exchanges and the CFTC.

While many new rules contain plausible protections, regulators have lost sight of the increased costs for FCMs. Most of the rules have been imposed without a true analysis of the effect on FCMs and end-users.119 As a result, many small- to medium-sized FCMs providing specialized services to everyday businesses are charging higher fees or leaving the industry because they cannot afford the additional infrastructure, technology and compliance costs imposed by the swelling regulations. With fewer firms serving a bigger market, risk is being more concentrated in the large bank-affiliated firms, increasing the systemic risk that Dodd-Frank promised to reduce.

A modern, dynamic economy can only prosper if it is supported by efficient banking sectors and capital markets featuring a large and diverse range of service providers meeting changing customer needs. Just as eco-systems in the natural world benefit from broad bio-diversity, so do vibrant and durable financial markets thrive best with a broad array of service providers and trading counterparties. Unfortunately, global financial markets are now undergoing a pronounced reduction in the bio-diversity of market service providers, with deleterious effects on market safety and soundness. Market regulators must find a way to reverse this trend, which threatens the systemic safety that Dodd-Frank was meant to preserve.

6. De-Globalization

Starting in the middle of the second half of the 20th century, regional and national markets for financial products expanded into global markets with the result of rising employment and standards of living for over a generation. The era produced a new term, “globalization,” denoting increasing interdependence of economic and cultural activities. Then came the financial crisis of 2008 and its political and regulatory response, which seems to have reversed the course of globalization in financial services. De-globalization is taking place despite the fact that worldwide trade in financial products was not a cause of the crisis.

In January of this year, I issued an extensive White Paper analyzing the mismatch between the CFTC’s swaps trading regulatory framework and the distinct liquidity and trading dynamics of the global swaps markets.120 This mismatch – and the application of this framework worldwide – has caused numerous harms, foremost of which is driving global market participants away from transacting with entities subject to CFTC swaps regulation, resulting in fragmented global swaps markets. Traditionally, users of swaps products chose to do business with global financial institutions based on factors such as quality of service, product expertise, financial resources and professional relationship. Now, those criteria are secondary to the question of the institution’s regulatory profile. Overseas market participants are avoiding financial firms bearing the scarlet letters of “U.S. person” in certain swaps products to steer clear of the CFTC’s problematic regulations. As a result, non-U.S. market participants’ efforts to escape the CFTC’s flawed swaps trading rules are fragmenting global swaps trading and driving global capital away from U.S. markets.

Since the start of the CFTC’s SEF regime in October 2013 and accelerating with mandatory SEF trading in February 2014, global swaps markets have divided into separate trading and liquidity pools: those in which U.S. persons are able to participate and those in which U.S. persons are shunned. Liquidity has been fractured between an on-SEF, U.S. person market on one side and an off-SEF, non-U.S. person market on the other.

According to a survey conducted by the International Swaps and Derivatives Association (ISDA), the market for euro interest-rate swaps (IRS) has effectively split.121 Volumes between European and U.S. dealers have declined 55 percent since the introduction of the U.S. SEF regime.122 The average cross-border volume of euro IRS transacted between European and U.S. dealers as a percentage of total euro IRS volume was twenty-five percent before the CFTC put its SEF regime in place and has fallen to just ten percent since.123

Fragmentation has exacerbated the already inherent challenge in swaps trading – adequate liquidity – and is increasing market fragility as a result.124 Fragmentation has led to smaller, disconnected liquidity pools and less efficient and more volatile pricing. Divided markets are more brittle, with shallower liquidity, posing a risk of failure in times of economic stress or crisis. Fragmentation has increased firms’ operational risks as they structure themselves to avoid U.S. rules and manage multiple liquidity pools in different jurisdictions (e.g., through different affiliates). As structural complexity has grown, operational efficiency has been reduced.

Another regulatory driver of market fragmentation are new requirements of U.S. bank prudential regulators for the exchange of initial margin between wholly-owned affiliates for uncleared swaps. Such rules discourage inter-affiliate risk management and will fragment hedging activity into local and regional regulatory jurisdictions.

Just as healthy financial markets require “bio-diversity” of service providers and trading participants, so do they benefit from broad continuity of trading systems. The current fragmentation of global financial markets may be likened to habitat fragmentation in the natural world, in which large, continuous biological habitats are divided into a greater number of smaller eco-systems, isolated from each other by a matrix of dissimilar habitats, leading inexorably to broad ecosystem decay.125 In a similar way, trading market fragmentation caused by ill-designed rules and burdensome regulations – and the application of those rules abroad – is harming market liquidity and market safety and soundness, increasing the systemic risk that the Dodd-Frank Act was predicated on reducing. Amidst the current tide of de-globalization and slowing world economic growth, market regulators cannot continue to ignore the growing systemic risk caused by market fragmentation.


Modern financial markets are like complex, global ecosystems in the natural world. Today, those ecosystems face six major challenges:

1. Relentless assault by hostile cyber predators;

2. Rapid habitat transformation by new digital technologies;

3. Single species overexpansion and dominance by “Washington Whale” central banks;

4. Nutrient and habitat diminishment through deterioration of trading liquidity;

5. Reduction in biodiversity of key market service providers; and

6. Habitat fragmentation of global trading environments;

Regulators and others with responsibility for financial markets must do the following to address these challenges: prioritize cyber risk resiliency, foster best practices for new trading technologies, counter the distortions caused by central bank market intervention, acknowledge and address the diminishing liquidity in trading markets and review and reduce the numerous poorly designed rules and regulations that are causing service-provider concentration and market fragmentation.

Contemporary arguments over the efficacy of the Dodd-Frank Act and its myriad mandates and prescriptions are increasingly tired and stale. They are especially so when it comes to financial markets in the 21st century. The fact of the matter is that Dodd-Frank provides very few solutions for the challenges that actually face today’s financial markets. In fact, Dodd-Frank provides barely any guidance for the complicated issues I described and, in some respects, further complicates them.

It is said that you can avoid reality, but you cannot avoid the consequences of avoiding reality.126 Only with clear-eyed attention to the true challenges facing contemporary markets can we ever restore the market vitality that will be necessary for broad-based economic prosperity. Flourishing capital markets are the answer to U.S. and global economic woes, not diminished trading and risk transfer. We must foster safe, sound and vibrant global markets for investment and risk management if we are ever to escape the “new mediocre” of prolonged economic stagnation.127

We must stop fighting the last crisis. The challenges facing our capital markets in the early part of the 21st century are not answered by Dodd-Frank. Yet, they can be addressed through a return to a healthy respect for market vibrancy, durability, diversity and regeneration. These challenges need to be faced squarely and intelligently without partisan politics. It is time to stop driving through the rear view mirror and take a good hard look at the road ahead.

1 James Rickards, The Death of Money: The Coming Collapse of the International Monetary System 19–28 (2014). Rickards posits that Osama Bin Laden anticipated widespread panic and value destruction in U.S. financial markets following the World Trade Center attacks to the extent that his cadre of operatives probably shorted the stocks of U.S. air transportation companies to benefit from their inside knowledge of the coming attack.

2 William J. Lynn III, Defending a New Domain: The Pentagon’s Cyberstrategy, Foreign Affairs, Sept.–Oct. 2010, at 97–108.

3 Elisabeth Bumiller & Thom Shanker, Panetta Warns of Dire Threat of Cyberattack on U.S., N.Y. Times, Oct. 11, 2012,

4 CFTC, Transcript: Staff Roundtable on Cybersecurity and System Safeguards Testing 5 (Mar. 18, 2015) (statement of Timothy G. Massad, Chairman, CFTC),

5 See Bumiller & Shanker, supra note 3 (observing that U.S. defense officials have issued dire warnings in response to “a recent wave of cyberattacks on large American financial institutions”).

6 Damian Paletta, Danny Yadron & Jennifer Valentino-DeVries, Cyberwar Ignites New Arms Race, Wall St. J., Oct. 12, 2015, at A1, A12 (“Governments have used computer attacks to mine and steal information, erase computers, disable bank networks and – in one extreme case – destroy nuclear centrifuges.”).

7 Tom C.W. Lin, The New Investor, 60 UCLA L. Rev. 678, 708 (2013) (citing Michael Riley & Ashlee Vance, The Code War, Business Week, July 25, 2011, at 51–52, 56).

8 See id. at 708–09; Paletta, Yadron & Valentino-DeVries, supra note 6 (asserting that “at least 29 countries have formal military or intelligence units dedicated to offensive hacking efforts”).

9 J. Christopher Giancarlo, Commissioner, CFTC, Keynote Address Before the 2015 ISDA Annual Asia Pacific Conference (Oct. 26, 2015),

10 A recent internal report by the CFTC’s chief economist looked at over 1.5 billion transactions across over 800 products on the Chicago Mercantile Exchange over a two-year period. It found that the percentage of automated trading in financial futures – such as those based on interest rates, currencies or equity indices – was 60 to 80 percent. But even among many physical commodities, there was a high degree of automated trading, such as 40 to 50 percent for many energy and metals products.

11 See Futures Industry Association, Comment Letter on Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (Dec. 11, 2013), at 2,; see also CME Group, Comment Letter on Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (Dec. 11, 2013), at 2–3,

12 See CME Group, supra note 11, at 2–3; Futures Industry Association, supra note 11, at 2.

13 See infra Part IV.

14 See Lin, supra note 7, at 692, 703 (explaining that “[d]uring periods of high uncertainty . . . high-frequency trading can exacerbate volatility and hurt liquidity by removing significant trading positions from the markets at warp speeds” and that “[t]he enhanced speed and interconnectedness of cyborg finance makes it more endogenously vulnerable to volatile crashes . . . .”); Katy Burne, The New Bond Market: Algorithms Trump Humans, Wall St. J., Sept. 24, 2015,

15 Yesha Yadav, How Algorithmic Trading Undermines Efficiency in Capital Markets, 68 Vand. L. Rev. 101, 138–46 (2015) (forthcoming).

16 Lin, supra note 7, at 716.

17 Id. at 712; Yadav, supra note 15, at 107–08.

18 See Lin, supra note 7, at 724. See generally Yesha Yadav, Insider Trading and Market Structure (forthcoming, UCLA L. Rev., 2016) (questioning whether current law is inadequate to restrict modern, automated electronic markets from being dominated by “structural insiders”).

19 See generally Yadav, supra note 15.

20 Giancarlo, supra note 9.

21 Lin, supra note 7, at 681.

22 Author’s own professional knowledge and experience.

23 See, e.g., Edward Robinson & Matthew Leising, Blythe Masters Tells Banks the Blockchain Changes Everything, Bloomberg, Sept. 1, 2015, See generally Galen Stops, Blockchain: Getting Beyond the Buzz, Profit & Loss, Aug.–Sept. 2015, at 20,

24 Massimo Morini & Robert Sams, Smart Derivatives Can Cure XVA Headaches, Risk Magazine, Aug. 27, 2015,; Stops, supra note 23, at 20–22.

25 Editorial, The Trust Machine, Economist, Oct. 31, 2015,

26 See, e.g., Larry Greenemeier, Can’t Touch This: New Encryption Scheme Targets Transaction Tampering, Scientific American, May 22, 2015,

27 Jon Watkins, Could the Blockchain Solve the Collateral Conundrum?, The Trade, Oct. 6, 2015,

28 Morini & Sams, supra note 24; Stops, supra note 23, at 22; see Jeffrey Maxim, UBS Bank Is Experimenting with “Smart-Bonds” Using the Bitcoin Blockchain, Bitcoin Magazine, June 12, 2015,; see also Pete Harris, UBS Exploring Smart Bonds on Block Chain, Block Chain Inside Out, June 15, 2015,

29 Jemima Kelly, Three Banks Join R3 Blockchain Consortium Taking Total to 25, Reuters, Oct. 28, 2015,

30 Anna Irrera, LSE, SocGen, CME, UBS Among Big Names in Blockchain Trade Push, Fin. News, Nov. 16, 2015,

31 Robleh Ali et al., Bank of England, Innovations in Payment Technologies and the Emergence of Digital Currencies 11 (2014),; see also Tomas Hirst, The Bank of England Just Said It Thinks Bitcoin Could Be Huge, Business Insider, Sept. 11, 2014,

32 Santander InnoVentures, Oliver Wyman & Anthemis Group, The Fintech Paper 2.0: Rebooting Financial Services 15 (2015), (asserting that blockchain technology could allow banks to save as much as $20 billion annually).

33 See Tamara Evan, University of Cambridge Judge Business School Centre for Risk Studies, The Art of Financial Network Science, Part II, Viewpoints, Sept. 28, 2015,

34 Alan Laubsch, Adaptive Risk Management: Powered By Network Science 2 (Fin. Network Analytics, 2015),

35 Id.

36 Financial Crisis Inquiry Commission, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States 298–300, 329, 363, 386 (2011),

37 7 U.S.C. § 24a (2012), Commodity Exchange Act § 21.

38 Silla Brush, Dodd-Frank Swap Data Fails to Catch JPMorgan Whale, O’Malia Says, Bloomberg, Mar. 19, 2013,

39 Neil Roland, IOSCO’s Wright Faults Authorities’ Coordination on Derivatives Trade Reporting, MLex FS Core, Nov. 18, 2015,

40 Under Sections 725, 728 and 763 of the Dodd-Frank Act, when a foreign regulator requests information from a U.S. registered swap data repository (SDR) or derivatives clearing organization (DCO), the SDR or DCO is required to receive a written agreement from the foreign regulator stating that it will abide by certain confidentiality requirements and will ‘‘indemnify’’ the CFTC for any expenses arising from litigation relating to the request for information. The concept of ‘‘indemnification’’ – requiring a party to contractually agree to pay for another party’s possible litigation expenses – is only well established in U.S. tort law, and does not exist in practice or in legal concept in many foreign jurisdictions, thereby introducing complications to data-sharing arrangements with foreign governments and raising the possibility of data fragmentation at the international level. Correcting this unworkable framework in the Dodd-Frank Act is not controversial, as the Securities and Exchange Commission endorsed in testimony before Congressional Committees in the 112th Congress. Similarly, in the 113th Congress, H.R. 742 was introduced to provide a narrow fix on this issue and passed the House of Representatives on June 12, 2013, by a vote of 420–2. In the 114th Congress, almost identical legislation, H.R. 1847, was introduced and again approved by the U.S. House with no objection via a voice vote on July 14, 2015. However, the problematic “indemnification” provision still remains in law.

41 Rand Paul & Mark Spitznagel, If Only the Fed Would Get Out of the Way, Wall St. J., Sept. 15, 2015,

42 Jeb Hensarling, Reining in a Sprawling Federal Reserve, Wall St. J., Nov. 20, 2015,

43 Lawrence Goodman & Stephen Dizard, Fixing the Fed’s Liquidity Mess, Wall St. J., July 21, 2015,

44 The Fed’s current $4 trillion position in U.S. government securities dwarfs JP Morgan’s 2012 $7 billion CDS position, notoriously referred to as the “London Whale.” See In re JP Morgan Chase Bank, N.A., CFTC Docket No. 14-01 (Oct. 16, 2013), at 8,

45 See James A. Dorn, The Pitfalls of the Federal Reserve Zero Interest Rate Policy, Cato Institute Commentary, Oct. 15, 2015,; James Grant, Magical Thinking Divorces Markets from Reality, Fin. Times, July 21, 2015,; Ruchir Sharma, The Federal Reserve Asset Bubble Machine, Wall St. J., May 11, 2015,

46 See, e.g., Adam Jeffery, Fed to Blame for Distorting U.S. Financial Markets?, CNBC, Mar. 6, 2014,

47 See, e.g., Nouriel Roubini, The Liquidity Time Bomb, Project Syndicate, May 31, 2015,

48 Mohamed A. El-Erian (former CEO, PIMCO), The Markets’ Disruptive Short-Term Fetish, Bloomberg, Sept. 28, 2015.

49 See Roubini, supra note 47.

50 Id.; Goodman & Dizard, supra note 43.

51 See Zhang Jun, China’s Malfunctioning Financial Regulation, Project Syndicate, Aug. 4, 2015; Junheng Li, The Repercussions of China’s Heavy-Handed Market Intervention, Forbes Asia, Aug. 2, 2015; Lingling Wei, China’s Response to Stock Rout Exposed Regulatory Disarray, Wall St. J., Aug. 4, 2015.

52 Editorial, Abenomics Sputters in Japan, Wall St. J., Nov. 16, 2015,; Mia Tahara-Stubbs, OECD Urges Japan to Keep an Eye on QE, CNBC, Apr. 16, 2015,; see also Jon Hartley, Bank Of Japan Announces More Quantitative Easing: The Next Chapter In Abenomics, Forbes, Nov. 2, 2014,

53 See European Insurance & Occupational Pensions Authority, Financial Stability Report 5, 18 (2015) (asserting that the European Central Bank’s quantitative easing program has greatly diminished the available volume of certain bonds, sapping liquidity and increasing volatility in those markets); see also Juliet Samuel, ECB Bond-Buying Increases Market Volatility, Says Regulatory Body, Wall St. J., June 1, 2015,

54 The Fed and the ECB are setting interest rates; the PBOC is setting currency rates and seeking to control equity prices.

55 Grant, supra note 45.

56 See Int’l Monetary Fund, Global Financial Stability Report 52 (2015), (explaining that “unconventional monetary policies involving protracted, large-scale asset purchases” have depleted market liquidity by “drastically reduc[ing] the net supply of certain securities available to investors”).

57 Joe Rennison, U.S. Treasuries Market Faces Liquidity Concerns, Fin. Times, July 29, 2015,; see also Xiao Wang, Market Liquidity Has Been Drained by Regulations, Says DBS Chief, Asia Risk, Sept. 17, 2015, (quoting Piyush Gupta, Chief Executive Officer, DBS Group).

58 Marius Zaharia, Investment Focus: As Liquidity Shrinks, Bond Trading Becomes a Grind, Reuters, June 12, 2015,

59 Int’l Monetary Fund, supra note 56, at 49–53; Joe Rennison, Market Liquidity Warning from IMF, Fin. Times, Sept. 30, 2015,; see also Bd. of Governors of the Fed. Reserve Sys., Senior Credit Officer Opinion Survey on Dealer Financing Terms 2 (Sept. 2015),; BlackRock, Viewpoint: Addressing Market Liquidity 1–2, 4–7, 9–10 (2015),; Tracy Alloway, Why Would Anyone Want to Restart the Credit Default Swaps Market?, Bloomberg, May 11, 2015,; Huw Jones, BoE Delves Deeper into Asset Managers, Uncertain Market Liquidity, Reuters, Sept. 25, 2015,

60 See Justin Baer, James Sterngold & Gregory Zuckerman, Large Banks Retreat from Trading Frenzy, Wall St. J., Sept. 3, 2015, at C1–C2.

61 See Peter Madigan, U.S. End-Users are Losers in Swaps Liquidity Split, Risk.Net, Apr. 28, 2014,

62 Lukas Becker & Catherine Contiguglia, Hidden Price Pressures Grow in Euro Swap Market, Risk Magazine, Sept. 8, 2015,

63 See Alloway, supra note 59; Michelle Davis & Hugh Son, Deutsche Bank Said in Talks to Sell $250 Billion Swaps Portfolio, Bloomberg, Oct. 8, 2015,

64 Callum Tanner, Illiquidity Worries U.K. Insurers in Forex Hedging Switch, Insurance Risk, Aug. 24, 2015,

65 See Bank for Int’l Settlements, 85th Annual Report 106 (2015),; Ryan Tracy, Banks Retreat From Market That Keeps Cash Flowing, Wall St. J., Aug. 13, 2014,; see also Goodman & Dizard, supra note 43 (citing data indicating that the availability of repurchase agreements, commercial paper and money-market funds is nearly 30% below the level reasonably needed to support liquid markets and economic growth).

66 See CFTC, Transcript: Energy and Environmental Markets Advisory Committee Meeting 108 (July 29, 2015),

67 Int’l Monetary Fund, supra note 56, at 49–53; Rennison, supra note 59.

68 Bank for Int’l Settlements, supra note 65, at 36–40 (citing the increasing “liquidity illusion” in which credit markets appear liquid and well-functioning in normal times, only to become highly illiquid upon market shock).

69 Jones, supra note 59.

70 Ian Katz, Yellen Says Regulators Ready to Act as Panel Cites Risks, Bloomberg, May 19, 2015,

71 Stephen A. Schwarzman, How the Next Financial Crisis Will Happen, Wall St. J., June 9, 2015,

72 Roubini, supra note 47.

73 See Lael Brainard, Governor, Bd. of Governors of the Fed. Reserve Sys., Address at the Policy Makers’ Panel on Financial Intermediation of the Salzburg Global Forum on Finance in a Changing World: Recent Changes in the Resilience of Market Liquidity (July 1, 2015) [hereinafter Resilience of Market Liquidity],

74 Michael S. Piwowar & J. Christopher Giancarlo, Banking Regulators Heighten Financial Market Risk, Reuters, July 12, 2015,; see CFTC, Transcript: Market Risk Advisory Committee Meeting 7–8, 90–101 (June 2, 2015),; Bank of England, Financial Stability Report 16–17 (2015),; see also Martin Wheatley, Chief Executive, Financial Conduct Authority, Keynote Speech at the Association for Financial Markets in Europe Annual European Market Liquidity Conference: From Intellectual Certainty to Debate (Feb. 25, 2015),

75 Sarah Krouse, Wall Street Bemoans Bond Market Liquidity Squeeze, Wall St. J., June 2, 2015,

76 Ira Jersey & William Marshall, Credit Suisse Research, Interest Rate Strategy Focus: Downside of Prudential Regulation: Lower Liquidity 1, 3–5 (2014),

77 Blackrock, supra note 59, at 1–2, 4–7, 9–10.

78 Wang, supra note 57.

79 Baer, Sterngold & Zuckerman, supra note 60, at C1–C2.

80 Id.; Adam Shell, Bond Rout Continues as U.S., German Yields Hit 9-Month Highs, USA Today, June 10, 2015,; Zaharia, supra note 58.

81 U.S. Dep’t of the Treasury, Bd. of Governors of the Fed. Reserve Sys., Fed. Reserve Bank of N.Y., U.S. Secs. & Exch. Comm’n & U.S. Commodity Futures Trading Comm’n, Joint Staff Report: The U.S. Treasury Market on October 15, 2014, at 1–2, 15–17 (2015),

82 Timothy Massad, Chairman, CFTC, Remarks Before the Conference on the Evolving Structure of the U.S. Treasury Market (Oct. 21, 2015), at 3,

83 See Baer, Sterngold & Zuckerman, supra note 60, at C1–C2; Roubini, supra note 47; see also Anthony J. Perrotta, Jr., An E-Trading Treasury Market “Flash Crash?” Not So Fast, Tabb Forum, Nov. 24, 2014,‘flash-crash’-not-so-fast.

84 See, e.g., Baer, Sterngold & Zuckerman, supra note 60, at C1–C2; see also Jersey & Marshall, supra note 76, at 1, 3–4; Ira Jersey & William Marshall, Credit Suisse Research, U.S. Interest Rate Strategy Focus: Diminished Market Depth and the Illusion of Liquidity 1–5 (2015),

85 Baer, Sterngold & Zuckerman, supra note 60, at C1–C2.

86 As noted by several commentators at the recent Federal Reserve Bank of New York conference. Conference on the Evolving Structure of the U.S. Treasury Market, Federal Reserve Bank of New York (Oct. 20–21, 2015).

87 Regulation 648/2012, 2012 O.J. (L 201) (EU), EMIR is a European Union regulation intended to enhance the stability of the over-the-counter (OTC) derivative markets throughout the EU states. It entered into force on August 16, 2012.

88 Directive 2014/65, 2014 O.J. (L 173) (EU),

89 Basel III (or the Third Basel Accord) is a global, voluntary regulatory framework on bank capital adequacy, stress testing and market liquidity risk. It was agreed upon by the members of the Basel Committee on Banking Supervision in 2010–11. The third installment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the financial crisis of 2007–08. Basel III is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage. See Basel Committee on Banking Supervision, International Regulatory Framework for Banks (Basel III), Bank for International Settlements, (last visited Nov. 17, 2015) [hereinafter Basel III].

90 Margin and Capital Requirements for Covered Swap Entities, 79 Fed. Reg. 57,348 (Sept. 24, 2014),

91 Letter from Mark Carney, Chairman, Financial Stability Board, to G20 Finance Ministers and Central Bank Governors, at 3 (Feb. 4, 2015),

92 Basel III, supra note 89.

93 See About the FSB, Financial Stability Board, (last visited Nov. 17, 2015).

94 Office of Management & Budget, Fiscal Year 2016 Budget of the U.S. Government 33 (2015),

95 Agostino Capponi, W. Allen Cheng & Sriram Rajan, Office of Financial Research, Systemic Risk: The Dynamics under Central Clearing 22 (2015),

96 Simon Nixon, Why Liquidity-Starved Markets Fear the Worst, Wall St. J., May 20, 2015,

97 Id.

98 FSOC, Annual Report 108 (2015),

99 A recent IMF Global Financial Stability Report discusses the need for more economic risk-taking to help the economy. See IMF, Global Financial Stability Report 43 (2014),

100 Even as it dampens growth-enhancing economic risk-taking, the current regulatory climate encourages unreasoned financial risk-taking. According to the IMF, central banks’ QE programs are driving a “search for yield” that pushes investors toward low-grade and illiquid financial products. See id.

101 Office of Financial Research, 2014 Annual Report 30–33 (2014),

102 Id.

103 Katz, supra note 70.

104 Resilience of Market Liquidity, supra note 73.

105 Id., Insight: High-Frequency Trading Liquidity Goes Phantom Again, EuroMoney, Aug. 2013,

106 See, e.g., Francesco Franzoni & Alberto Plazzi, What Constrains Liquidity Provision? Evidence From Hedge Fund Trades 1–4, 25–26 (Swiss Fin. Inst., 2015),; Schwarzman, supra note 71; see also Baer, Sterngold & Zuckerman, supra note 60.

107 See supra note 49 and accompanying text.

108 Testimony Before the Subcomm. on Economic Growth, Job Creation, and Regulatory Affairs of the H. Comm. on Oversight and Government Reform on the Impact of Dodd-Frank on Community Banking, 113th Cong. 1, 3–7 (2013) (statement of Hester Peirce, Senior Research Fellow, The Mercatus Center at George Mason University),; see also Testimony Before the H. Financial Services Comm. on The Dodd-Frank Act Five Years Later: Are We More Prosperous?, 114th Cong. 6 (2015) (statement of Peter J. Wallison, Arthur F. Burns Fellow in Financial Policy Studies, American Enterprise Institute); Hester Peirce & Stephen Matteo Miller, The Mercatus Center at George Mason University, Small Banks by the Numbers, 2000–2014, at 4–5 (2015); David Smith, Consolidations, Regulations Pare Banks, Execs Say, Arkansas Online, Sept. 20, 2015,

109 See, e.g., Justin Baer & Juliet Chung, Goldman Sachs Cuts Roster of Hedge-Fund Clients, Wall St. J., Aug. 4, 2015,; Baer, Sterngold & Zuckerman, supra note 60; Georgina Hurst, Cautious Hedge Funds Spell Big Business for Custody Banks, Institutional Investor, Aug. 20, 2015,; Edward Krudy, Prime Brokerages Consolidate After “Big Bang,” Reuters, Apr. 16, 2012,; James Shotter & Daniel Schäfer, Credit Suisse to Shrink Prime Brokerage, Fin. Times, Dec. 7, 2014,

110 Ivy Schmerken, SEF Consolidation Likely as Volumes Slowly Increase, Information week: Wall St. & Tech., Aug. 21, 2014,; see Chad Bray, Tullett Prebon Agrees to Buy ICAP’s Global Brokering Business, N.Y. Times, Nov. 11, 2015,; Chad Bray, BGC Partners Gains Control of GFI Group, N.Y. Times, Feb. 27, 2015,; see also J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank 54–55 (2015),; Philip Stafford, Exchanges and Interdealer Brokers Reshape to Face Fragmenting Market, Fin. Times, Nov. 17, 2015,

111 J. Christopher Giancarlo, Commissioner, CFTC, Statement for the Market Risk Advisory Committee Meeting (June 1, 2015), According to CFTC data, the number of FCMs has dramatically fallen in the past 40 years, from over 400 in the late 1970s, to 154 before the 2008 financial crisis, and down to only 57 active firms serving customers as of March 2015. As the number of FCMs has dwindled, systemic risk has increased, with the five largest firms accounting for more than 70 percent of the market. Meanwhile, customer assets held by the remaining FCMs have grown from $169.5 billion in December 2007 to $245.7 billion in March 2015. See generally Joe Rennison, Nomura Exits Swaps Clearing for US and European Customers, Fin. Times, May 12, 2015,

112 17 C.F.R. § 1.25 (2014); John McCrank, Ranks of Commodities Brokers Dwindle as U.S. Futures Industry Evolves, Reuters, July 2, 2015,

113 Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 Fed. Reg. 68,506, 68,510–12 (Nov. 14, 2013), (discussing recent customer protection initiatives).

114 Ownership and Control Reports, Forms 102/102S, 40/40S, and 71, 78 Fed. Reg. 69,178 (Nov. 18, 2013),

115 17 C.F.R. § 1.35 (2014). The recordkeeping requirements apply to transactions in a commodity interest and related cash or forward transactions. Oral communications that lead solely to the execution of a related cash or forward transaction are excluded.

116 Peter Madigan, FCMs Try to “Off-Board” Credit and Commodity Funds, Risk Magazine, July 30, 2015,

117 Regulatory Capital Rules: Regulatory Capital, Revisions to the Supplementary Leverage Ratio, 79 Fed. Reg. 57,725, 57,735 (Sept. 26, 2014),

118 Madigan, supra note 116.

119 7 U.S.C. § 19(1) (2012), Commodity Exchange Act § 15(a).

120 Giancarlo, supra note 110.

121 See ISDA, Cross-Border Fragmentation of Global Interest Rate Derivatives: The New Normal? First Half 2015 Update 1–3 (2015) [hereinafter ISDA Update],; see also Philip Stafford, US Swaps Trading Rules Have “Split Market,” Fin. Times, Jan. 21, 2014, Beginning in October 2013 after the SEF rules’ compliance date, European dealers dramatically moved away from trading with U.S. counterparties, beginning to trade almost exclusively with other European counterparties in the market for euro IRS. In October 2013, 91 percent of euro IRS trades took place between two European counterparties, while only 9 percent occurred between a U.S. and a European dealer. By August 2014, these numbers moved to 96 percent and 3 percent, respectively. Recently, in June 2015, 89 percent of euro IRS trades were between two European counterparties, while 10 percent of euro IRS trades were between a European and U.S. counterparty. Compare these figures with those from a month before the SEF rules’ compliance date, when 71 percent of euro IRS trades were between two European counterparties and 29 percent between a U.S. and European dealer. This has been a clear shift in trading behavior for European dealers. See ISDA Update, supra, at 3, 15–16. This observation is also supported by an ISDA survey wherein 68 percent of non-U.S. market participant respondents indicated that they have reduced or ceased trading with U.S. persons. ISDA, Footnote 88 and Market Fragmentation: An ISDA Survey 3–4 (2013),

122 ISDA Update, supra note 121, at 2, 18.

123 Id. at 18.

124 Referring to the manifest liquidity split between London and New York, Dexter Senft, Morgan Stanley’s co-head of fixed income electronic markets, said, “I liken [SEF liquidity] to a canary in a coal mine. It’s not dead yet, but it’s lying on its side.” Kim Hunter, Growing Pains, Markit Magazine, Winter 2014, at 30, 31,

125 See Raphael K. Didham, The University of Western Australia & CSIRO Ecosystem Sciences, Ecological Consequences of Habitat Fragmentation 1–2 (2010),

126 Attributed to Ayn Rand.

127 Christine Lagarde, the Managing Director of the IMF, has dubbed current economic conditions as the “new mediocre.” Editorial, The “New Mediocre,” Wall St. J., Oct. 16, 2014,

Last Updated: December 1, 2015